Al·ter·na·tive In·vest·ments (noun.)

One way to define alternative investments is by what they are not - traditional stocks, bonds and real estate. In fact, they include a very wide range of diverse assets. Alternatives can be grouped into 3 broad categories:

Hard assets: Farmland, timberland and oil & gas wells are good examples that are familiar to most, but this group also includes unique real estate such as emerging market properties and even collectables such as art, wine, coins and musical instruments.

Businesses: A passive investment in a business such as a share in a retail store, factory, Internet start-up or even a film project. These are typically referred to as private equity or venture capital deals.

Trading Programs: This group normally gets referred to as "hedge funds" or its popular subset, managed futures programs. Hedge funds are very different from the last two types in that they are really an investment in a manager who is making trades, not a fund that owns physical things or businesses. The items traded vary widely but most utilize commodity and futures contracts, stocks, bonds or options.

The term "hedge fund" can be a bit confusing. It generally refers to the last group of trading programs but it many times is used very loosely to cover almost any type of alternative asset. In any case, keep in mind that the word "hedge" is a misnomer. Hedging your portfolio is not necessarily the primary goal of these programs but is hopefully a welcome byproduct. The reasons for investing in alternative investments can be any or all of the following:

a tool to reduce overall portfolio risk through diversification (the hedge part);

an opportunity to capture potentially high rates of return;

or simply an investment that seeks to take advantage of opportunities outside the realms of traditional stocks, bonds and common real estate.

For all their desirable features, alternative investments come with a few drawbacks. They may be relatively illiquid and difficult to price accurately on a regular basis and their fee structures are normally higher than traditional investments. When selecting which to invest in, things like risk level, potential profit, liquidity, costs and diversification potential all need to be considered. Alternative assets are generally not traded on stock exchanges, but still must meet certain government regulations. You need to be aware of which programs are designed for Qualified investors, Accredited investors and those without any minimum, open to anyone suitable. To increase your probability of being a successful investor in alternative assets, it is important to always do your homework. If that seems daunting or too time consuming, you have the option of using a broker or advisor. Be sure to choose one that is experienced, professional and preferably specializes in this very wide ranging and unique asset class.

David Swensen, the very successful manager of the Yale University's endowment, has effectively utilized alternative investments for many years and was an early pioneer in this regard. The following is a summarization of his views on the asset class:

Alternatives are a legitimate source of return totally independent from stocks - and if chosen properly, can provide equity-like returns driven by fundamentally different underlying factors."